Free Financial Advice has Hidden Costs: Motivations Matter

Here is a common retirement investment scenario for Baby Boomers.  Mr. Jones is retiring and has different options available in his pension plan.

  • Option 1 – Accept a large lump sum, transfer it tax-free to an IRA and invest it for his future. He is personally accepting the risk of investing the money to help provide for the rest of his and his wife’s life.
  • Option 2 – Begin receiving guaranteed monthly payments for the rest of his life (and his wife’s life with survivor benefits).  This option places the risks and rewards of investing solely on the pension plan.

Since this decision is irrevocable and involves hundreds of thousands of dollars, Mr. Jones wants professional advice.

When you Pay a Financial Adviser, What are You Paying For?

Advisers who are paid solely by managing investments, selling investments or insurance may be more likely to give advice that pays a commission.  An adviser like this is incentivized to recommend Mr. Jones take the lump sum and roll it over to an IRA. After all, that would generate revenue for the adviser. There may be some cases where the adviser would recommend the monthly lifetime income, but that would provide no compensation to the adviser described here. Is that likely?

On the other hand, Mr. Jones may choose to partner with a professional who is compensated simply for providing this type of financial planning advice.  In other words, the cost for advice may be completely independent of the cost of products. Then there is no incentive for the advice to be skewed either way. The professional would be providing her best advice because that’s exactly what Mr. Jones is paying for – unbiased advice.

A Commissioned Financial Adviser has Conflicts

Consider another common example. Let’s assume Mr. Jones also has a large balance in his employer’s 401(k).  As illustrated above, an adviser compensated by selling investments cannot be paid unless the 401(k) is rolled over to an IRA. Buying the IRA is the only way for the adviser to be paid for his advice.  There are many technical reasons Mr. Jones may want to consider not rolling over his 401(k) to an IRA, but his adviser has a conflict.

Because financial advisers have been compensated like this, the U.S. Department of Labor has released a rule requiring financial advice (for retirement accounts only) to be in the best interests of the client. This is often referred to as the fiduciary rule. (Not all financial advisers are legally required to act in their clients’ best interests.)  Many financial organizations are filing lawsuits in an attempt to stop this fiduciary rule from becoming law. This rule will be implemented over time to give traditional firms time to change.

Good Financial Advice is Worth the Price

Do motivations matter? We believe so and have built a business model where we put our clients’ interests first at all times. In fact, we put it in writing.  If you’d like to explore what a partnership with our team involves, we’d be honored to talk with you.

For more detail on pension election decisions (monthly income vs. lump sum), watch these short videos.


start-the-conversationTerry Prather

Published: October 5, 2016

Author: Terry Prather, CFP®, ChFC®, MSFS

Email: twprather@paynewealthpartners.com

Phone: (812) 602-6307

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The information in this material is only as current as the date indicted, and may be superseded by subsequent market events or for other reasons. Statements concerning financial market trends are based on current market conditions, which are subject to change and which Payne Wealth Partners, Inc. does not undertake to update. While all information prepared in this document is believed to be accurate, any statements of opinion constitute only current opinions of Payne Wealth Partners, Inc., which are subject to change and which Payne Wealth Partners, Inc. does not undertake to update. Accordingly, you should not put undue reliance on these statements.

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About the author

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Terry Prather

Terry Prather tries to strike a healthy balance between today and tomorrow.

In his position as a Wealth Planner with Keystone Financial Consulting, Terry helps families use their financial resources to accomplish what’s most important to them. “I help families evaluate and balance their long-term financial independence with all their other life goals,” he says. “These families often want to be responsible with the financial resources available to them to do good things for family and the causes they’re passionate about. We all make financial decisions every day, and I have the privilege of helping clients make these decisions in context of their long-term picture.”

Had he not found college physics to be boring, he might not have ever become a wealth planner. Initially Terry pursued an engineering degree, but lacked enthusiasm for the physics classes in his major. When he switched colleges and changed majors, the pieces began to fall into place. He discovered an aptitude for accounting, and after graduation found himself drawn to financial planning. This desire eventually led Terry to earn the CERTIFIED FINANCIAL PLANNERTM certification and then pursue a Master of Science in Financial Services, and each day he uses this knowledge to help families find that healthy balance between today and tomorrow.

“I enjoy being face-to-face with our clients, and I like being able to explain the more technical aspects, explain how their strategy works,” says Terry. “We like it when clients walk away feeling they received a lot of value, that we’ve used their resources effectively.”

As a man with a strong, faith-filled Christian background, Terry devotes a good bit of his free time toward music ministry in his church, New Life Church in Newburgh. Terry and his wife Paula share their talents through singing and playing guitar (Terry) and keyboards (Paula) and are sometimes joined by their three children in this endeavor. They also like to spend time as a family outdoors, visiting Holiday World and Paoli Peaks, riding bikes, hiking, and swimming.

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